What You Should Know About Interest Only Mortgages
When it comes to financing a home purchase or refinance, there are many options to consider. One type of mortgage that has gained popularity in recent years is the interest-only mortgage. While it may seem attractive at first glance, it’s essential to understand the pros and cons of this type of mortgage before making a decision.
What is an Interest-Only Mortgage?
An interest-only mortgage is a type of home loan where the borrower only pays the interest on the loan for a set period, usually 5-10 years, before transitioning to a principal and interest payment schedule. This type of mortgage is also known as an IO or interest-only loan.
Pros of Interest-Only Mortgages
1. Lower Monthly Payments: With an interest-only mortgage, your monthly payments will be lower compared to a traditional amortizing loan, where you pay both interest and principal. This can be especially beneficial for borrowers who need to make ends meet or have a limited budget.
2. Flexibility: Interest-only mortgages often offer more flexible repayment terms, allowing borrowers to adjust their payment schedule or make extra payments without penalty.
3. Tax Benefits: The interest paid on an interest-only mortgage may be tax-deductible, which can help reduce your taxable income.
Cons of Interest-Only Mortgages
1. No Equity Build-Up: Since you’re only paying interest and not principal, you won’t be building equity in your home during the interest-only period. This means that if you sell your home or need to refinance, you won’t have any equity to tap into.
2. Higher Total Cost: While your monthly payments may be lower, you’ll pay more in interest over the life of the loan due to the extended period of just paying interest.
3. Risk of Higher Payments: When the interest-only period ends, your monthly payments will increase significantly as you begin paying both interest and principal. This can be a shock to your budget if you’re not prepared.
4. Limited Credit Availability: Interest-only mortgages are not as widely available as traditional mortgages, and lenders often have stricter qualification criteria.
Who is an Interest-Only Mortgage Suitable For?
Interest-only mortgages are typically suitable for borrowers who:
1. Have a High Income: If you have a high income and can afford the higher payments when the interest-only period ends, an IO mortgage might be a good option.
2. Plan to Sell or Refinance Soon: If you plan to sell or refinance your home within the interest-only period, an IO mortgage allows you to minimize your upfront costs and enjoy lower monthly payments.
3. Need Flexibility: If you need flexibility in your repayment terms or have irregular income streams, an IO mortgage provides more flexibility than traditional mortgages.
How to Make an Interest-Only Mortgage Work for You
To make an interest-only mortgage work for you:
1. Plan Ahead: Understand that the interest-only period will eventually end, and you’ll need to adjust to higher payments.
2. Budget for Higher Payments: Set aside money each month for when the interest-only period ends and payments increase.
3. Make Extra Payments: Consider making extra payments during the interest-only period to reduce the principal balance and minimize the impact of higher payments later on.
In conclusion, while interest-only mortgages can offer attractive benefits, it’s crucial to carefully consider the pros and cons before making a decision. Borrowers should weigh their financial situation, goals, and risk tolerance before choosing this type of mortgage. With careful planning and budgeting, an IO mortgage can be a viable option for those who need flexibility and lower monthly payments in the short term. However, it’s essential to remember that higher payments will eventually kick in, so it’s vital to plan ahead and prepare for this eventuality.
Those interested in seeking out a mortgage loan to purchase property or real estate will often times find the undertaking quite confusing. Mortgages are often times complex procedures, in many ways due to the different types of mortgage loans that exist. Among the many that are offered, the interest only mortgage loan has become one of the commonly sought after mortgages in recent time.
What is Interest Only Mortgage?
An interest only mortgage loan is the type of loan in which the borrower will only be required to make payments to the applied interest of the loan for specified period of time. The interest only mortgage will not necessitate making payments on both the principal loan amount and the interest.
In the United States, the interest only mortgage will have either a five or ten year period in which payments are made solely to cover the interest of the loan. The main factor of attraction to borrowers regarding the interest only mortgage loan is that during the interest only period, the monthly payments will be substantially lower than those to be made if monthly payments were to cover both interest and the principal amount.
Advantages of an Interest Only Mortgage?
There various aspects in regards to an interest only mortgage that makes it an attractive option to those seeking out mortgage loans. One of the main issues is the fact that it provides for the ability to make smaller monthly payments during the interest only period.
This factor can help borrowers obtain mortgages for homes or property that they would otherwise not be able to afford. Aside from this aspect, interest only mortgage loans are also attractive in situations when the real estate market and prices will prove to be high during a particular period of time.
In only making payments to the interest of the loan, this allows borrowers more flexibility in their financial considerations. Individuals that have made recent career advancements which are to provide for a substantial increase in income may often times consider an interest only mortgage.
For example, if the individual is expected to double his/her salary over a period of five to ten years, this will allow for that person to purchase a home that might be out his/her budget at the given time, but affordable once the income increase is implemented in his/her career.
Interest only mortgage loans are also popular with those with substantial financial backing or income. Initially, interest only mortgage loans were only offered to the best qualified applicants, though the practice has changed in recent times.
In this particular situation, it allows those with wealth to only make payments on the interest, freeing up fiscal considerations to invest elsewhere. Often times, such investments would prove to be profitable enough to cover the principal amounts once the interest only period expires. This would essentially save such individuals a good amount of money in the process.
Disadvantages of Interest Only Mortgages
Though the advantages of an interest only mortgage will prove to be very attractive to most, such type of loan will prove not to be beneficial to everyone. At first, interest only loans would only be offered with those with substantial financial capabilities, for such a type of loan is a considerable risk to lenders.
Interest only loans will often times not be the best option, particularly for first time home buyers. Though the lower payments in the initial interest-free period may be attractive enough, if first time home buyers suffer any kind of financial hardship in the future, they may experience trouble making the higher monthly payments based on the remainder principal amount.
Investors in real estate will encounter a similar situation, particularly if the interest only mortgage is considered based on the actual real estate market. Many times, investors will obtain an interest only mortgage loan based on a rising real estate markets, thus increasing the value of the property and the potential earnings of the investment.
However, if the prediction in the market is wrong and property values decrease, the investor will now have a property that is worth less the total amount owed on the interest only mortgage loan.
